European Central Bank Big Debt Game

When the financial crisis came in 2007 and 2008, the big central banks and main regulators discovered that many big banks and financial institutions did not have enough capital to handle the losses from their risk-taking, which turned out to be very excessive.

Banks had to be saved along with a few countries. Taxpayers had to take on these risks, either by taking on the debt burden with tax money, or with guarantees.

Many nations suffered economic stress because their banks started to reduce lending to SME’s and bigger companies or simply pulled the plug on weaker borrowers forcing them into bankruptcy. Economic activity fell rather sharply, as did tax revenues, and governments then set about trying to find ways to stimulate the economies.

Central banks came into the picture because they could reduce interest rates and support banks with cheap financing. The idea being that banks could lend more at lower interest rates to stimulate investments. This central bank financing for banks was really cheap – well below the market rates that the banks would normally pay. It ensured that the banks would return to profitability more quickly and strengthen their capital base again.

That was the basic idea, but it did not work so well. Many banks were exposed to the governments of Spain, Italy, France, Greece, Portugal, and several other countries that had big exposures to badly managed big banks. These banks had been buying huge amounts of their long-term government bonds with their short-term deposits and other funds. This mismatch was killing them along with the losses from the real estate market and from company loans. As the banks went down, so did the governments that tried to support them. It was a horrible vicious circle…

So then the European Central Bank, the Bank of England and the US Federal Reserve Bank came up with anew idea which they call “Quantitive Easing”. This is just a fancy word for buying their government bonds in huge amounts to further lower long-term interest rates and stimulate their respective economies.

When the European Central Bank (ECB) buys the EuroZone’s government bonds it effectively reduces interest rates and lowers the cost of borrowing for EuroZone member states as well as absorbing these bonds from the markets.

Today the ECB owns around €2,6 trillion which means that for every person living in the EuroZone (around 344 million) has around €7 400 of EuroZone government bonds if spread evenly. For Finland that means that Finns are on the hook for some €40 billion debt held by the central bank, a number that is around a massive 30% of our GDP… That basically means that the central bank has printed money to buy government bonds. If the holdings are all Finnish government bonds then that is fine because Finland is not breaching the Maastricht borrowing limits, but the European Central Bank is buying a lot of Italian bonds too and other government bonds from weaker countries.

The big question is then:”Are we exposed to them too?” Our central bank is also part of the European Central Bank?

You may recall Finland’s former PM’s exuberance when we agreed to lend money to a failing Greece, he described it as a “great deal!” Lucky us for great losses, and probably much more to come.

The German Constitutional Court is now considering the legality of the ECB’s “Quantitive Easing”. It is clearly forbidden for the ECB to finance governments – here are quotes on this subject from the FT 30.7.2019:

“Eurozone treaties prevent the ECB from financing member states’ governments by buying their debt, a tactic known as monetary financing. This rule aims to protect the central bank from political pressure and avoid stoking inflation. QE involves the central banks of eurozone member states buying government bonds in massive quantities, financed by the ECB.”

The ECB claims that it is buying from the secondary markets and not directly from the governments in the primary market. That is a complete fabrication because they are buying from investment banks and have no idea from where the bonds are coming! The amounts are also so huge that there can be no doubt that these purchases by the ECB are nothing more than state financing. It is quite clear that few private institutional investors would be buying bonds with negative interest rates of highly rated issuers, or bonds with such low rates from more risky countries like Greece and Italy. The lawyers and judges must be really naive to believe otherwise.

These low interest rates have not created much investment nor are they good for savers. The only ones who have profited are the banks, and we all know that most banks do very little lending these days to the real economy, while some banks pay their bosses huge bonuses from their strong profits.

It is worth remembering that few bank bosses have much skin in the game. Very few own significant amounts of shares where they work. Central bankers have absolutely no ownership in their own work places by definition. In both cases they are playing with other peoples’ money for which taxpayers are ultimately responsible. Moral hazard is on the loose again big time…